401(k) loan: how much you can borrow, repayment rules and the real cost

A 401(k) loan lets you borrow from your own vested balance and repay it, with interest, back into your account through payroll deductions. Under IRS rules you can generally borrow the lesser of $50,000 or the greater of $10,000 and half your vested balance, and you must repay within five years unless the loan is for your main home. As long as you keep up the repayments, the loan is not taxed and carries no early-withdrawal penalty.

That last condition carries most of the risk. A 401(k) loan is cheap and simple while you stay employed and keep paying. It becomes expensive very quickly if you miss payments or leave your job with a balance outstanding, because the unpaid amount can be treated as a taxable distribution.

How a 401(k) loan works

When you take a loan, the plan sells investments in your account to raise the cash and pays it to you. The loan becomes an asset of your own account: a receivable, in accounting terms. Each repayment, usually taken straight from your paycheck, goes back into your account and is reinvested according to your elections. The interest you pay also goes into your account rather than to a bank.

Three features follow from that structure:

• No credit check. You are borrowing your own money, so the plan does not underwrite you in the way a bank would. Plan loans are generally not reported to credit bureaus.
• No tax on the loan itself. A loan that meets the IRS rules is not a distribution, so there is no income tax and no 10% early-distribution tax when you receive it.
• Your balance stops investing. The borrowed amount is out of the market until you repay it. That is the hidden cost discussed below.

Plans are not required to offer loans. Whether yours does, the interest rate, the minimum loan amount, how many loans you can have at once and any setup fee are all set by the plan document. Your summary plan description or the plan's website will state them. Some plans also require your spouse's written consent before a loan is made.

How much you can borrow

The IRS maximum is the lesser of:

• $50,000, or
• the greater of $10,000 or 50% of your vested account balance.

In practice, for most people this works out to half the vested balance, capped at $50,000. The $10,000 floor matters only for small balances, and a plan is not obliged to use it. If you have had another loan in the previous 12 months, the $50,000 figure is reduced by the highest outstanding loan balance during that period, which stops people from repaying and immediately reborrowing to get around the cap.

Illustrative examples (assumptions only):

Vested balance	50% of vested balance	Maximum loan under the IRS formula
$16,000	$8,000	$8,000 to $10,000, depending on whether the plan uses the $10,000 floor
$60,000	$30,000	$30,000
$140,000	$70,000	$50,000 (capped)

Only the vested balance counts. Employer contributions that have not yet vested cannot be borrowed against. Your plan may set a lower limit than the IRS maximum, so check your own plan's rules before relying on these figures.

Repayment rules

The loan must generally be repaid within five years through substantially level payments that include principal and interest, made at least quarterly. Most plans collect payments every payday.

A loan used to buy your principal residence can have a longer repayment period. The IRS does not set a fixed maximum for home loans; the plan decides, and some plans do not offer the extended term at all.

Payments can be suspended in two situations:

• Leave of absence. A plan may suspend repayments during an unpaid or low-paid leave of up to one year. When you return, the loan still has to be repaid within the original term, so the payments increase.
• Military service. Repayments can be suspended during qualifying military service, and the loan term can be extended by the period of service.

Most plans also let you repay early without penalty.

What happens if you miss payments

If a required payment is missed, plans commonly allow a cure period, which can run until the end of the calendar quarter after the quarter in which the payment was due. If the missed payment is not made up by then, the loan is in default.

The IRS treats a defaulted loan as a deemed distribution of the entire outstanding balance. That amount is added to your taxable income for the year, and if you are under 59½ it generally carries the 10% additional tax as well, unless an exception applies. A deemed distribution cannot be rolled over to avoid the tax. It is reported to you on Form 1099-R.

The loan balance does not disappear from the plan's records at that point, and in some plans a deemed distribution restricts your ability to take further loans. The tax, however, is due as though you had withdrawn the money.

Leaving your job with a loan outstanding

This is where most 401(k) loans go wrong. Many plans require the full outstanding balance to be repaid when you separate from service. If you do not repay it, the plan reduces your account by the unpaid balance. This is a plan loan offset.

A loan offset is treated as an actual distribution, which means it can be rolled over. For a qualified plan loan offset, one caused by leaving your job or by the plan terminating, you have until your tax return due date for that year, including extensions, to deposit an equal amount into an IRA or another eligible plan. If you do, the offset is not taxed.

The practical difficulty is that you must find the cash from elsewhere to make that rollover deposit. People who took the loan because they were short of cash often cannot, and the offset becomes taxable income, plus the 10% additional tax if under 59½ and no exception such as the rule of 55 applies. If you are planning a move, our 401(k) rollover guide covers how the remaining balance can be transferred.

Some plans let former employees keep repaying a loan after they leave, usually by direct debit. Check whether yours does before you give notice.

The real cost of a 401(k) loan

The interest rate is the visible cost, and it is the least important one, because you pay it to yourself. Three other costs matter more.

Missed investment growth

Money on loan earns only the interest you pay back, not the return the account would have earned. If markets rise sharply while the loan is outstanding, the gap can be significant. If markets fall, the loan can end up looking cheap in hindsight. Nobody knows which in advance, so treat the lost growth as a real but uncertain cost.

Reduced or paused contributions

Loan repayments come from take-home pay. If the repayments squeeze your budget and you cut your regular contributions, you may lose part of an employer match as well as the tax deferral on those contributions. This is often the largest cost of all and the easiest to avoid.

Interest paid with after-tax money

You repay a 401(k) loan from after-tax pay, and pre-tax money you later withdraw in retirement is taxed. This is often described as "double taxation" of the whole loan, which overstates it. The principal you repay is simply replacing pre-tax money you borrowed. The interest portion, however, is paid with after-tax dollars into a pre-tax account and will be taxed again when withdrawn. On most loans the interest is a modest share of the total, so this effect is small but real.

401(k) loan vs hardship withdrawal and other options

Option	Taxed when received?	10% penalty under 59½?	Must be repaid?	Main risk
401(k) loan	No, if rules are met	No, if rules are met	Yes	Default or leaving your job
Hardship withdrawal	Yes	Usually, unless an exception applies	No, and cannot be put back	Permanent loss of retirement savings
Personal loan or credit card	No	No	Yes	Interest cost, credit impact
Home equity borrowing	No	No	Yes	Home is security

A loan is often less damaging than a hardship withdrawal because the money goes back into your account. It is not always better than outside borrowing: if your job is insecure, the offset risk can make an unsecured loan the safer option despite a higher rate. Note that IRAs, including SEP and SIMPLE IRAs, do not offer loans at all.

Questions to ask before you borrow

1. Does my plan allow loans, and what are its limits, fees and interest rate?
2. How secure is my job over the repayment period?
3. If I left, would the plan let me keep repaying, or would it offset the loan?
4. Can I keep my contributions at the level needed for the full employer match while repaying?
5. Is there a cheaper or lower-risk source of cash?

Frequently asked questions

Is a 401(k) loan taxable?

Not if it meets the IRS limits and is repaid on schedule. It becomes taxable if it defaults and is treated as a deemed distribution, or if it is offset against your account after you leave your job and you do not roll over an equal amount by the deadline.

Can I have more than one 401(k) loan?

The IRS rules allow more than one loan as long as the combined balance stays within the maximum. Many plans limit participants to one or two loans at a time, so check your plan document.

Does a 401(k) loan affect my credit score?

Plan loans are generally not reported to credit bureaus, and there is no credit check to take one. A default is handled through the tax system rather than collections, which is why the tax consequence is the thing to watch.

Can I use a 401(k) loan to buy a house?

Yes, if your plan allows it. A loan used to buy your principal residence may qualify for a repayment term longer than five years, depending on the plan. Mortgage lenders may count the repayments in your debt-to-income ratio, so ask your lender before you commit.

This article is general education, not personal financial or tax advice. Plan rules vary and IRS rules change, so confirm the details with your plan administrator and a qualified tax professional before borrowing.